China Unicom's Long-Distance Leap

The telecommunications boom has come to a halt in the United States and Europe. But China Unicom is racing forward. As China embraces Internet-based telephony, its telecommunications future is being beta-tested in Guangzhou.

It's a soggy afternoon in Guangzhou, and a bicycle courier is struggling along a six-lane boulevard. Five computer-monitor boxes are strapped to a tiny rack over his bike's back wheel, and only a blue tarpaulin protects his cargo from the rain. A bumper crop of billboards praise the virtues of Giordano jeans, Anna Sui handbags, and other fashionable consumer goods. Spanning the roadway, suspended from an overpass, is an even bolder message carried on an enormous red banner. The pitch: Join legions of satisfied telephone customers by jumping on the voice over Internet protocol (VOIP) bandwagon.

Huh? Fewer than 10% of the people in China have any kind of telephone at all. And while Guangzhou is one of China's busiest port cities, it's never been a high-tech trendsetter. The dominant industries are textiles and light manufacturing, as Guangzhou feverishly tries to keep pace with nearby Hong Kong.

But something remarkable is going on. Billions of dollars are pouring in to create one of the world's most advanced VOIP networks. The result: larger call loads and cheaper per-minute rates. In countries such as the United States, where a strong telephone infrastructure already exists, installing a VOIP network is daunting. But in China, where phone networks are less advanced, it represents an opportunity to leapfrog generations and land smack in the middle of the most advanced telecom technology in the world. Guangzhou, as the nation's commercial and industrial hub, plays host to the vast majority of China's Internet telephony. As China embraces the future of telephony, that future is being beta-tested in Guangzhou.

Dialing for Dollars

The company leading the charge is China Unicom Ltd., an operation that didn't even exist until seven years ago, when the government first opened the market to competition. Now Unicom, with annual revenue of nearly $3 billion, is one of six telecom providers in China. Its mandate is to build a 21st-century phone system by betting the company on Internet telephony. "We believe that, in the future, packet-switching networks will replace traditional telephony," says Liang Jian Hao, the general manager of Unicom's Guangdong VOIP operations. "Our goal is to lead this revolution."

In August, China Unicom completed the second of three phases in its network buildout, giving it the world's largest VOIP network. It has connected 327 cities throughout mainland China to its four network hubs in Guangzhou, and it has built international Internet protocol gateways in Beijing, Guangzhou, and Shanghai. The network is densest near China's eastern coast, offering the greatest capacity to that region's larger, more commercial cities — but it also extends 1,200 miles inland to Lanzhou. Phase three of the project will see further expansion into China's most rural communities.

The Coca-Cola Co., Ford Motor Co., and other Western companies have long dreamed of capturing the market of a billion Chinese people. So far, they have made only limited progress, perhaps because no single product is compelling enough to create that kind of demand. Telephone service, however, is different. Now that China Telecom no longer maintains a state-supported monopoly of voice-and-data communications, its five recently created rivals — Unicom among them — each are scrambling for a piece of the market of 65 billion long-distance minutes that Chinese businesses and individuals generate each year.

China Unicom and its employees would seem unlikely candidates to lead a business revolution. The business-casual cultural transformation of Silicon Valley hasn't made its way to the company's offices in Guangzhou and Hong Kong. Formally dressed employees hold meetings in rooms decorated with little-used beige-leather couches and ceremonial porcelain vases filled with dried flowers. The atmosphere is calm, controlled — far from the frenzied pace of work that one might expect of a company that continues to expand at a dizzying rate.

Unicom has built its network hubs on land that five years ago was a series of ponds outside Guangzhou's city limits — one indication of how much the city has expanded in that time and how rapidly the telecommunications industry is gobbling up available land and resources.

Last year, Unicom had the capacity to provide 1.1 billion long-distance minutes in China — including both VOIP and traditional calls. Now Unicom's IP network has the capacity to support up to 10 billion minutes annually. Actual usage in 2000 totaled just 690 million minutes — a far cry from a controlling interest in the long-distance market, or even in the IP market. But according to Li Zheng Mao, executive director and vice president in charge of Unicom's Hong Kong office, which oversees the publicly traded portion of Unicom's assets, use of the VOIP network is rising on a daily basis. In just the first four months of 2001, Unicom hosted 790 million minutes of traffic on the network, on track to more than triple the totals from last year. Unicom's figures for 2000 represent an approximately 25% share of the Chinese VOIP market. Officials hope that with usage rates climbing at the current pace, Unicom's market share will reach the 50% level by the end of 2003.

Calling the Right Customers

Who accounts for these huge jumps in usage? Until recently, the representative customer was someone like Johnson Zhao, a Guangzhou engineer who has friends in different parts of China and overseas, and who is not intimidated by new technology. An early adopter by nature, Zhao purchased a $6.05 VOIP calling card from China Unicom when the network was in its most nascent phase. "I remember the first time I used VOIP," he recalls. "It was 1999, and I wanted to call my friend in America. When I told him I was using VOIP, he didn't believe me — the sound quality was that good."

Now, however, that image of the customer is changing. As the network has expanded and as IP calling cards have gained in popularity, Unicom is looking for new recruits among farmers, families, and wage earners in the cities. Against conventional wisdom, which argues that only large enterprises could be interested in such envelope-pushing technology as VOIP, Unicom officials are betting that the local market will be the key to IP's success. They believe that the ideal customer is an average resident with no special interest in technology — just a desire to make phone calls at the best rates.

"Individuals care about price more than anything else," says Liang by way of explanation. And price is one of the strongest selling points of Unicom's version of VOIP. While a traditional phone call to the United States from Guangzhou costs approximately $1.75 per minute, Unicom's VOIP service offers rates as low as $0.45 per minute. Domestic long-distance rates over the VOIP network are similarly low: Calls to other Chinese cities cost less than $0.04 per minute.

Business customers, on the other hand, are far more concerned with voice quality and security, and Unicom does not yet have the bandwidth in place to ensure the 100% reliability of calls that such customers would demand. Even the possibility of dropped calls or fuzzy sound quality is too much for many businesses to risk, says Liang.

By focusing on individual users and their price sensitivity, Unicom hopes to capitalize on its ability to offer per-minute rates at a fraction of the cost of traditional calls. This will enable the company to continue building a large, loyal customer base of long-distance callers while it fine-tunes the voice quality of the new network. Liang expects that customer satisfaction with long-distance services will soon translate to more users signing up with Unicom for local IP service. By then, Unicom hopes to have a firm hold on the consumer market and to be ready to handle the higher quality-and-security demands of business-enterprise users.

Perhaps the strongest argument for VOIP's future success in China, however, is that using it doesn't change the way individuals are used to interacting with the telephone. For users who have phones in their homes, selection of Unicom's VOIP service is as easy as checking off a box on the monthly bill, or making a call to the customer-service center. There is no new hardware to purchase and no new interface to learn.

For residential users who aren't ready to commit to the service, or for callers without a personal phone line, the purchase of prepaid calling cards is the simple alternative. Unicom has an access number — 17910 — that can be dialed from any telephone on the mainland and that will immediately connect the caller to the company's IP network. In China, as in much of Asia, calling cards are an everyday part of the culture — used for everything from mobile-phone calls to pay-phone minutes. So even though IP telephony is a potentially disruptive technology for the marketplace, it doesn't act disruptively in people's lives. Users still interact with the phone in the same way they always have — it's just cheaper.

Unicom vs. Telecom

Despite the advantages Unicom has, a few challenges stand between it and VOIP victory. First is China Telecom, the state-owned former monopoly and still the largest telecom provider in China. Even though Unicom was first-to-market with its VOIP network, and currently boasts the most extensive IP infrastructure, China Telecom is now hot on Unicom's heels with its own VOIP buildout.

The streets of Guangzhou bear witness to the battle of the telecom giants: ripped-up concrete and constant jackhammering mark the locations where China Unicom and China Telecom are laying cables to expand their respective networks as quickly as possible in their fight for market share. Though Unicom is winning the battle in terms of network size, Telecom has a stronger brand image and a larger existing customer base. It will take all of Unicom's many flamboyant advertisements, banners, and promotions to get the word out about its better network and cheaper prices.

The possibility of technical glitches also looms. Building a network this large and depending on a technology this new has risks. It is a delicate dance between enticing legions of customers to jump on the bandwagon and building the capacity to support them if they actually show up. Bandwidth is an issue. Maintaining voice quality and security in the face of overwhelming usage is an issue as well.

But Unicom officials believe that they have a winner. Their investment of a billion yuan, or about $120 million, is significant — but it's only about 30% of what the company would have spent to build a traditional telephone network and compete for the business of these same customers. The 5,000 high-speed E-1 lines (analogous to T-1 lines in the United States) in Guangzhou alone provide enough bandwidth for 10 times the number of minutes currently in use on the nationwide network, and Unicom continues to add capacity. And the rapid rise in numbers of customers using the IP service is testament itself to customer satisfaction, say officials.

American hardware providers like Cisco Systems, Sun Microsystems, and 3Com are betting that Unicom is right. They all have benefited from the infrastructure investments made by Chinese telecom providers, and Unicom uses hardware from all three companies. Of the three, Cisco has the biggest stake: In June, Cisco and Unicom announced a partnership under which Cisco will provide network hardware and engineering support to Unicom for all of its future VOIP needs.

With Cisco unable to expand in the United States during the current economic slowdown, IP telephony represents a major opportunity for the networking giant. "China has a population of a billion people," says Alec Henderson, manager of product marketing for Cisco's Voice Technology Center. "Because of that market's sheer size, there's almost unlimited potential. You can make any estimate you want about potential market share."

Alison Overholt (aoverholt@fastcompany.com) is a Fast Company staff writer based in Silicon Valley. Learn more about China Unicom on the Web (www.chinaunicom.net).

Sidebar: Caller ID

Few Americans are as familiar with voice over Internet protocol (VOIP) as the customers of China Unicom are. But Americans may be using this technology without even knowing it. If someone in the United States makes regular calls to China — or to Australia, Germany, or any of the other 65 countries served by iBasis Inc., a 5-year-old outfit in Burlington, Massachusetts — that call may have been carried over an IP network.

Unlike China Unicom, which contracts directly with customers to provide VOIP service, iBasis is a wholesaler of VOIP service. Long-distance companies subcontract with iBasis to put calls through using IP telephony. If iBasis does its job right, end users aren't able to detect a difference in sound quality between VOIP calls and traditional calls — and they may never realize that they've used IP service.

IBasis serves more than 110 carriers worldwide, including 10 of the 11 largest long-distance companies in the United States. According to CEO Ofer Gneezy, it carries about 20% of the voice traffic from the United States to China. "Not only that," he says, "but our network carries between 10% and 35% of calls to 14 other countries from the U.S., including Russia and Brazil." Gneezy adds that iBasis sells its IP services at a discount of up to 25%.

Do customers see any of that savings? "It depends," Gneezy admits. "Carriers may decide to pass some of that on to customers. But they may also use the lower cost of providing the calls to realize higher margins."

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